This is the year my cousin Mike and his wife plan to buy a home. Their confidence waned in March 2020 for obvious reasons, but his career actually grew due to a restructuring at the office. As they watched the news, they also watched mortgage rates falling.
"We had our hopes on a 3.50% rate when we started out," Mike said. "I'd used an amortization table template in Excel to figure out how much our monthly payment would be for homes of various prices and at various interest rates, and 3.5% is the rate I plugged in most of the time."
Did Covid-19 discourage the first-time home buyers? Mike said, "All of a sudden nothing was normal anymore and we considered putting our home search on hold. But rates in our area nudged down, then down again. We realized that our timing was fortunate after all."
Before starting the mortgage search, Mike already had a preapproval letter confirming the size of the loan amount he would be able to get. He also had a signed purchase and sale agreement for a house.
Prequalified Isn't Preapproved
A mortgage preapproval is an official estimate confirming your mortgage potential based on proof of income, proof of assets, and credit score. By contrast, a mortgage "prequalification" is merely an estimate of your loan potential based on your answers to a few questions.
By comparison shopping, gathering the right paperwork, and negotiating closing costs and other variables with lenders, Mike secured an outstanding rate of 2.79%—lower than he'd ever hoped for. Here are the techniques he used.
You Better Shop Around
Home buyers in general search too little for the best mortgage. Nearly half of consumers go with their first mortgage offer. They rely on the relationship they have with a bank, or go with a referral from a friend or a real estate agent, and don't shop around.
Freddie Mac's research indicates that borrowers could save $1,500 over the life of the loan by getting just one more quote and about $3,000 by getting five quotes.
Consumers can also benefit by shopping for the lowest fees, in addition to the lowest rates. Researchers Susan Woodward and Robert Hall documented that variations in consumer mortgage searches led to large differences in broker fees. By not shopping effectively, typical borrowers paid $1,000 more in broker fees charged to originate their mortgage.
Mike received five quotes by asking for lender recommendations from friends and family, as well as seeing which lenders were most interested in him in the rate shopping service Lendgo.
He started the home loan search in mid-June. In July, U.S. mortgage rates had dropped to a record low of 3.19%.
Mike didn't just want a lender with low rates, but also one with a good reputation. His wife, Iris, researched each lender in the complaint database maintained by the Consumer Financial Protection Bureau. Here you can look up your state and see complaints submitted over the past three years.
So shopping around means not only acquiring four or five quotes but also weeding out quotes from lenders with shady reputations and questionable business practices.
The stronger your financials, the more lenders will negotiate to get your business. You strengthen your negotiating position by having:
- A higher credit score.
- A bigger down payment.
- Lower monthly debts.
Compare Estimates to Estimates
People can feel overwhelmed comparing complex options, and they retreat to the simplicity of sticking to a first alternative, even against their own financial interest. Such were the findings of Richard Thaler, whose paper won the 2017 Nobel Prize for economics.
Mortgages are definitely complex, but you can ease the hassle by comparing estimates to estimates. Terminology matters: insist on estimates.
You ask for a mortgage estimate, and the lender sends some other kind of paperwork. It happens more often than you might expect considering there's been a law since 2015 requiring lenders to supply official loan estimates within three days of receiving your application. So why don't they? The substitute paperwork isn't just faster for the lender, but it is also designed to disguise negatives and draw your attention away from consequences.
A true loan estimate runs down all of the important details over three pages, including:
- Your estimated monthly payment
- Interest rate
- Closing costs
- Any prepayment penalty and other key features of the loan
A loan estimate also clearly indicates which details can change before closing. The substitute paperwork nearly always glosses over impending, surprise changes.
To eliminate as much of the confusion as you can when comparing mortgage offers, be sure to have true estimates in front of you. That way you are comparing apples to apples.
"One of the lenders sent us a slick and professional-looking 'closing analysis,'" Mike said. "I had to request a proper estimate. They wanted to walk me through their analysis on the phone and answer any of my concerns. They were very proud of it, but I wasn't going to play that game. I wanted the same standardized quotes from everyone, for a side-by-side comparison."
Pit Lenders Against One Another
Mike didn't request five quotes only so that he would know more of his options in the current mortgage landscape. He got them because each quote is irrefutable proof of competition.
"The rates we got ranged from 3.625% down to 3%," Mike said. "The lowest closing costs we found was about $6,500, and the highest was just over $10,000."
Now Mike and Iris wanted to see which lender would step up. Which lender would be willing to lower its rate to match the competition? Which would match the lowest closing costs?
It's not just about the interest rate but also the closing costs, points, and fees. The lender with the lowest upfront rate might not be the best for you over the life of the loan, but you can send that loan estimate to your preferred lender and ask for a match.
Some lenders have always been more efficient than others. Today's most efficient lenders lower their overhead costs with online applications and software-driven analysis and pass along the savings to borrowers. Other lenders make their profit by dealing in high volume and can therefore afford to charge lower rates and fees. Lenders can't always budge on their rate, but it's worthwhile to send the better estimate to them and ask if they can update their estimate right away.
Mike was thrilled when his preferred lender, which already had reasonable closing costs, agreed to match another estimate's lower interest rate. It also agreed to waive the loan application fee. Mike was all set to finance the home at the excellent rate of 2.89%. And then rates dropped again.
We don't hear much good news in a pandemic, but the timing for his loan couldn't have been better. When the negotiation dust settled and the time came to lock in the loan, Mike's rate was an astonishing 2.79%.
Use the same techniques he did to secure the lowest mortgage rate you can and the best overall loan. Fewer people are in a position to buy a home today compared to just six months ago. Lenders want customers. The competition is stiff, and lenders will fight for your business.